Title: Markets Think The Fed Is Certain To Keep Rates Steady This Week. Why 3 Experts Say That Could Be A Mistake. – Business Insider
You can almost hear the collective sigh of relief on Wall Street. After a brutal series of interest rate hikes that made borrowing money feel like a luxury from a bygone era, the financial markets have decided the fight is over. They’re placing their bets, with near-total certainty, that the Federal Reserve is done hiking and will hold rates steady at its meeting this week. It’s practically a foregone conclusion, baked into every stock price and bond yield.
But what if everyone is getting a little too comfortable?
What if, in their race to declare victory over inflation, investors are misreading the room and the data? I’ve been talking to economists and market strategists who are watching the same numbers as everyone else, but they’re coming to a radically different, and far more uncomfortable, conclusion. They see a Fed that is not out of ammunition, but one that might be forced to fire another shot—a move that would blindside a complacent market.
The consensus is so one-sided that it’s starting to feel like a trap. The market isn’t just expecting a pause; it’s pricing in a permanent ceasefire. And that, my friends, is a dangerous assumption to make.
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The Case for Complacency: Why Everyone Thinks the Fed is Done
Let’s be fair to the market optimists. Their confidence isn’t completely pulled out of thin air. There are some solid, logical reasons for believing the hiking cycle has reached its peak.
The most obvious one is that inflation has actually cooled down. Remember the panic when gas was five dollars a gallon and your grocery bill looked like a mortgage payment? Those days have, for now, receded. The Consumer Price Index (CPI) has fallen significantly from its terrifying peak. The Fed’s preferred gauge, the Personal Consumption Expenditures (PCE) index, is also moving in the right direction.
This gives the Fed what they love most: optionality. They can afford to sit back, watch the data, and see if their previous rate hikes continue to work their way through the economy. There’s no immediate, screaming need to act.
Then there’s the “higher for longer” narrative. The official Fed line has been that they plan to keep rates at their current elevated level for a considerable time. The market has happily latched onto the “longer” part while ignoring the “higher” part. The thinking goes, “Why hike again when you can just maintain this restrictive pressure indefinitely?”
Finally, there’s a growing awareness that the full impact of the rate hikes we’ve already had hasn’t even hit the economy yet. It operates on a lag. The economy might just be waiting for a tidal wave of previous rate hikes to finally crash ashore. Piling on another one could be overkill, like adding an extra scoop of salt to a soup that’s already boiling over.
So, the pause makes sense. But certainty? That’s where the trouble begins.
The Labor Market is a Jekyll and Hyde Story
The first expert I spoke with, a chief economist at a major financial firm who asked not to be named because they regularly brief the Fed, pointed directly at the jobs report. “The market is celebrating the cooling of headline inflation numbers, but it’s completely ignoring the monster in the room: the unsustainably hot labor market,” they told me.
Think about it. The unemployment rate is still sitting near historic lows. Companies are still hiring. Wages are growing. On the surface, that sounds fantastic. For the Fed, however, it’s a major headache.
Wage growth is a powerful, sticky fuel for inflation. If people are earning more money, they keep spending more money. This sustained demand makes it incredibly difficult for price pressures to fully dissipate. You can’t have a stable, 2% inflation rate when paychecks are rising at a 4%+ clip. It’s a simple math problem.
The economist laid it out plainly: “The Fed has a dual mandate: stable prices and maximum employment. Right now, those two goals are in direct conflict. To truly kill inflation, they may need to see a material weakening in the jobs market. So far, that just isn’t happening in a meaningful way.”
The market is looking at a strong jobs report and seeing a soft landing. This expert is looking at the same report and seeing a reason for the Fed to hit the brakes one more time. It’s a classic case of whether you see the glass as half full or half empty, except the glass is filled with rocket fuel.
Financial Conditions Have Loosened. A Lot.
The second expert, a veteran market strategist, pointed to a more subtle but equally dangerous trend. “The Fed’s entire game is about tightening financial conditions,” she explained. “They raise rates to make it more expensive to borrow for a car, a house, or a business expansion. That cools down the economy. It’s Economics 101.”
But here’s the kicker. The moment the Fed started pausing, the market took it as a green light to party. Stock markets rallied, corporate bond issuance picked up, and mortgage rates dipped from their highs. In essence, Wall Street undid a big chunk of the Fed’s hard work.
This is the perverse feedback loop the Fed hates. They hike rates to slow things down, the market interprets the end of hiking as a reason to speed things up again. It’s like a parent taking away their kid’s candy, only for the kid to find a secret stash the moment the parent leaves the room.
“If you’re Jay Powell,” the strategist continued, “and you see your policy decisions actually stimulating the economy you’re trying to cool, what do you do? You might have to deliver a hawkish surprise. You might need to hike again, not because the last CPI print was awful, but to re-tighten the conditions that the market has loosened for you.”
This isn’t about punishing the market. It’s about the Fed maintaining its credibility. If the market doesn’t believe the Fed is serious, then the Fed loses its most powerful tool: its influence over psychology. A surprise hike would be a brutal, but effective, way to regain control.
The Last Mile of Inflation is the Hardest
We’ve all seen the charts. The inflation line shoots up like a rocket and then plummets back down. It’s easy to look at that downward slope and think, “Mission accomplished.” The third expert, an academic who studies inflation dynamics, warned me that this is a critical error.
“The easy wins are behind us,” he said bluntly. “Supply chains have been fixed. Energy prices have stabilized. The low-hanging fruit has been picked. The last mile of inflation is driven by stubborn, entrenched services prices that won’t go down without a fight.”
What falls into this category? Think your haircut, your restaurant meal, your hotel stay, your healthcare costs. These prices are intensely linked to wages. They don’t respond quickly to interest rate changes. They are the final boss in the Fed’s inflation-fighting video game.
The recent data has shown that these core services, excluding housing, are still running hot. This is the number the Fed watches like a hawk, and it’s not behaving itself.
“The market is pricing in a smooth, linear path back to 2%,” the academic noted. “But history suggests it’s never that simple. There are often second waves, sticky patches, and resurgences. If the data over the next month shows these core services re-accelerating, the Fed will have no choice. A ‘skip’ in September becomes a ‘hike’ in November, and the market will be caught completely offsides.”
So, What Happens Next?
Sitting in his chair this week, Jay Powell has a choice. He can give the market what it wants—a steady hand, a reassuring pause, and a pat on the back. Or he can give it what it might need—a sharp reminder that the fight isn’t over.
The safe bet is on the pause. The betting markets and analyst community are overwhelmingly convinced of it. But safe bets are sometimes losing bets.
The real risk isn’t that the economy is too weak; it’s that it remains too strong for the Fed’s comfort. A resilient consumer, a tight labor market, and loosened financial conditions create a recipe for inflationary pressures to make an unwelcome comeback.
If the Fed does surprise everyone with a hike, or even delivers a shockingly hawkish message that a hike is imminent, the reaction will be swift and ugly. The stock market rally would likely evaporate. Bond yields, which have already been climbing, could shoot higher. The collective narrative of a “soft landing” would be replaced by the terrifying specter of “overtightening.”
The experts I spoke with aren’t necessarily predicting a hike this week. They are, however, sounding a loud alarm about the market’s blind spot. By pricing in absolute certainty, traders have left no room for error, no room for a Fed that might still be worried, and no room for a data stream that could suddenly turn sour.
In the world of central banking, the most dangerous thing isn’t always the action itself. It’s the gap between expectation and reality. Right now, that gap is widening into a chasm. And everyone on Wall Street is busy pretending it isn’t there.
